The Mirage of Economic Efficiency

Almost 70 years ago, George Stigler introduced the concept of flexibility. A business might be highly efficient, but it may not have the flexibility to meet changing conditions. Stigler's point is largely ignored. I would prefer that other parts of his work were ignored, but I do not have much say in such matters.

Stigler, George. 1939. "Production and Distribution in the Short Run." Journal of Political Economy, 47 (June): pp. 304-27.

Stigler' point is fairly simple. Nuclear power plants are often used to explain what he meant. Assume, for the sake of argument only, that a nuclear power plant can produce electricity much cheaper than other forms of generation (by the way, I do not believe this assumption is correct). The problem is that demand shifts. The capacity to produce for peak demand might not be needed 90% of the time, making it an economical.

A coal fueled plant might be far less efficient, but it can be brought online relatively quickly when it is needed. Even though the engineering efficiency of the coal-fired plant might be low, it might be appropriate for handling peak loads.




Uncertainty makes Stigler's theory even more compelling. A biological example from my book, The Perverse Economy, might be appropriate.

"Biologists of all stripes acknowledge an amazing ability of various plants and animals to adapt to specialized niches. For example, scientists have recently discovered a new species, wholly unrelated to any previously known species, which survives on the lips of one particular type of lobster (Morris 1995). Although this form of evolution is remarkable, it also leaves the creatures vulnerable to even a slight change in the environment. The same specialization that made these creatures so dependent on the success of a relatively small group of lobsters makes them less adaptable to relatively small changes in the global environment. For example, this particular group of lobsters may decline or migrate to a less desirable location, threatening the existence of their tiny lip dwellers."

In the Perverse Economy, I used another example, regarding a glue shortage -- not glue in general, but a particular kind of glue. A computer chip is a silicon wafer, which is useless without the capacity to send and receive signals from a circuit board. A plastic package allows the chip to make the connection between the chip and the board. The industry uses specialized epoxy glue for fabricating these packages.

During the 1990s, a single Sumitomo Corporation plant manufactured the majority of the world's supply of the epoxy resin. About 60% of all memory modules depended on the product of this particular factory, when in July 1993 a fire destroyed this factory.

Ordinarily, an event like a fire in a glue factory not be of very much interest except for the people close to the event, but this fire ravaged the chip market. Dealers had been paying about $33 for a megabyte of memory before the fire. By the end of the month, the same memory commanded $95. The industry feared that prices would go even higher.

Bill Clinton's trade policy with Haiti illustrates a similar danger. Clinton forced Haiti open up its agricultural markets. Heavily subsidized US rice destroyed Haiti's capacity to produce rice. In terms of conventional economic theory, some economists might have seen Clinton's policy as efficient, following the laws of conventional economics (subsidies are ignored in this logic, especially the heavy water subsidies given to California rice growers). Relatively unproductive rice farmers would give up that activity to participate in the modernization of Haiti, presumably in some sweatshop.

Unfortunately, when agricultural prices began to soar, Haiti was unable to quickly resuscitate its previous capacity to grow rice. Food riots soon followed.

The recent sawdust shock is relevant here. Here is what the Wall Street Journal reported about sawdust:

"The price of sawdust has soared since 2006, up from about $25 a ton to more than $100 in some markets. Blame the housing slump: Fewer new homes mean fewer trees cut for use in construction, which leads to less sawdust and other wood waste, driving up the price."

"Farms use sawdust and wood shavings as cozy and clean bedding for horses and chickens. Particle-board makers devour it by the boxcar to fashion a cheap building material. Auto-parts manufacturers blend a finely pulverized sawdust called "wood flour" with plastic polymers to make a lightweight material to cover steering wheels and dashboards."

"Wineries use oak sawdust as a flavoring agent for some wines. Perdue Farms, which raises broiler chickens, goes through seven million cubic feet of wood shavings a year. Oil-rig operators in Wyoming and Colorado pour sawdust into the caverns they find deep inside rock formations as they hunt for pools of petroleum. Sawdust gives drill bits something to grind through."

"The housing slump has devastated sawmill production across the country."

Millman, Joel. 2008. "Sawdust Shock: A Shortage Looms As Economy Slows." Wall Street Journal (3 March): p. A 1.http://online.wsj.com/article/SB120451039119406735.html